Removing foreign exchange red tape good for retirement funds

The significant shift away from controlling foreign exchange transactions to a surveillance of cross-border financial transactions by the South African Reserve Bank will have a substantial impact on South African retirement funds.

Announcing fundamental changes in foreign exchange controls last month, Finance Minister Trevor Manuel said the reform was aimed at replacing unnecessary administrative controls with improved surveillance as commonly applied internationally.

Bernard Fick, Head of Institutional Business at Prudential Portfolio Managers SA, says although this change still has to be implemented it will positively impact on the way fund managers manage the foreign portion of a retirement fund’s assets.

He says an added bonus for the retirement industry is the fact that the 15% foreign exposure limit will increase to 20% once Regulation 28 of the Pension Funds Act has been amended. The increase in the limit was proposed as part of last month’s Budget.

Regulation 28 imposes limits on the investments of retirement funds aimed at protecting funds and their members against imprudent investment decisions.

“Currently we have to apply to the Exchange Control Department within the Reserve Bank before we can buy foreign assets on behalf of investors like retirement funds. Often it takes weeks before permission is granted and by that time the investment environment may have changed and opportunities passed.”

Fick says once the Reserve Bank’s Exchange Control Department has changed to the Financial Surveillance Department, asset managers no longer need to ask for permission before they can take money offshore.

This does not mean, however, that there will be no supervision. “Retirement funds will still be required to submit quarterly reports outlining their offshore exposure and indicate how they will reduce any excessive exposure and by when.”

Fick explains that the Reserve Banks levies penalties on retirement funds that exceed the foreign exchange limit without an acceptable plan of how this will be corrected.

“While we welcome the fact that we will be able to invest up to 20% of a retirement fund’s asset offshore, there is currently not much scope for additional offshore transfers as most retirement portfolios probably exceed their 15% offshore limit as a result of rand weakness over recent months. We suspect that most funds will currently be close to the 20% limit in any event. The relaxation of exchange controls will mean that these funds will not be forced to repatriate their offshore assets in excess of the old 15% limit.”

He says the added flexibility of being able to invest money offshore very quickly combined with the additional capacity will definitely make a difference to how institutional portfolios are diversified going forward.

“This will provide our asset managers will much greater scope to apply more active currency and regional asset allocation strategies to retirement portfolios.”

Fick points out that this will also place greater responsibility on trustees to pick asset managers with a solid understanding of global markets and opportunities they present.

He says retirement funds should include foreign exposure in their portfolios for the following reasons:

• To diversify the portfolio, by investing in economies at different stages in their economic cycles.
• To diversify against single currency risk.
• To enhance performance by investing in economic sectors that might not be represented in South Africa, for example computer software and motor manufacturing.

Fick points out that trustees must not forget that retirement fund liabilities are rand-denominated, and that holding non-rand assets does introduce the risk of a mismatch between assets and liabilities.

“It is therefore important that any foreign exposure must be expected to provide returns that help the fund support this liability, and to compensate for the currency mismatch risk.”